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Losing Your Earnest Money

Question: The contract I just signed to purchaser a house contained the following language: "If the buyer defaults, the earnest money will be forfeited to the seller. This is to be considered liquidated damages and not as a penalty". Can you please explain what this means? Beth.

Answer: Shame on you, Beth, for signing a contract without fully understanding what it means. It could have required that your car and your current pension plans be given to the seller if you did not go to closing (escrow). (Just kidding, but stranger things have happened when people sign something they don't understand).

In your case, should you not be able to finalize the deal, you will have to forfeit (ie lose) the earnest money you posted when you initially signed the sales contract. But the law is clear that if the amount you are forfeiting is not consistent with what the seller may have lost because you did not go to closing -- but instead is really a penalty -- the law will not allow you to lose your deposit.

So lawyers put in the language you question about to protect the sellers.

However, that does not mean you will lose your deposit, if you can prove that the money is disproportionate to the actual loss that your seller may face.

Oversimplified, the damages will be accepted as "liquidated" if the seller cannot really anticipate what the losses will be should you default. Accordingly, it is typical for that language to appear in real estate contracts.

So, for my buyer readers, try to post as little of a deposit as possible; and for my seller clients, try to get as large a deposit as possible.

Hopefully, you will eventually split the difference. And of course, this is completely academic if the buyer closes the deal.

Question: I am a teacher and I live in a co-op. I paid $200,000 cash for my apartment in 2003. In 2008, I took out a HELOC loan on my equity. I now owe $75, 000 on it. When I signed the papers, I was told that if I did not sell my home before principal and interest payment kick in (March 2017) I would just need to apply for refinancing. I did that a few months ago while rates were low and everything was set within a week. My FICO score hovers at 800 and I only owe a monthly plan for a new air conditioner on which I pay more each month than the monthly requirement. At the last minute I was called by the bank to say "sorry, we no longer finance co-ops as we did when you got yours." My payment will go up about $450 for an grand total of $640 a month. As a teacher who has not had a raise in a long time, I can not afford this payment. I have never been late on any payment for anything and don't live beyond my means. I can not find an instance where my co-op had a problem with a bank. In checking around, I have not been able to find any local banks who finance co-ops, especially for such a low amount.

Any suggestions? I do not want to sell my house and renting is astronomical. Kim.

Answer: Dear Kim: Assuming your cooperative apartment did not dramatically go down in value since you bought it some 14 years ago, you clearly have considerable equity. I know that not every lender is prepared -- or even understands -- how cooperative funding works, but clearly there are lenders out there that can assist.

First, is there a teacher's credit union near you? From my experience, many credit unions will make you a loan based primarily on your credit standing. They need to take the ownership certificate (often called "shareloan certificate) as security but that is something that any local real estate attorney can easily assist in doing.

Another source of lending is the National Cooperative Bank. Although its main office is in Arlington, Virginia, they make loans all over the United States. (www.ncb.coop).

Question: My husband and I plan to buy an investment property, and want to make sure our other assets are protected. What is the best way for us to take title? Emily.

Answer: Dear Emily: as I just wrote to another reader, I cannot provide specific legal advice. However, in general, there are three ways in which title can be held.

First, individually, in the names of you and your husband. That provides the least protection. Even if you have more than adequate insurance -- including umbrella coverage -- there is always the possibility that your other assets can be grabbed. For example, a court judgment exceeds the insurance limits; or the insurance carrier declines coverage for reasons spelled out in the insurance policy.

Next, you can take title in the name of a corporation. Talk with your financial advisors about this approach; from my experience, there is too much paper work and corporate filings required to make this a favorable option.

Next, you can take title in the name of a limited liability company (LLC). Although I don't normally make recommendations, this is what I generally suggest to my investor clients. The LLC provides the same protection as if it were a corporation but with less complications and less paperwork. Oversimplified, it is called a "pass through" entity; the LLC files an information tax return but the profits or losses are "passed through" and you include those numbers on your individual tax returns.

Every project is different; review these alternative but discuss with your financial and legal advisors. And the recent tax proposals submitted to Congress by the President seem to favor "pass-through legal entities, as we all know, Congress has the final say.

Author of the weekly Housing Counsel column with The Washington Post for nearly 30 years, Benny Kass is the senior partner with the Washington, DC law firm of Kass, Mitek & Kass, PLLC and a specialist in such real estate legal areas as commercial and residential financing, closings, foreclosures and workouts.

Mr. Kass is a Charter Member of the College of Community Association Attorneys, and has written extensively about community association issues. In addition, he is a life member of the National Conference of Commissioners on Uniform State Laws. In this capacity, he has been involved in the development of almost all of the Commission’s real estate laws, including the Uniform Common Interest Ownership Act which has been adopted in many states.